New direct tax code fails to connect the infrastructure dots - The Honest Truth By Ajit Dayal
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Investing in India - Honest Truth by Ajit Dayal
New direct tax code fails to connect the infrastructure dots A  A  A
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30 JULY 2010


Not only do the armchair Planners - or the more active implementers of the unplanned Plan - have yet to prove to us that they have vision of the India they wish to build, but the men in power have also shown themselves to be clueless about how they wish to finance that massive infrastructure build out.

Take the Direct Tax Code that is being showcased for comments before it winds itself into law. Most of us are aware about the high savings rate in India and most of us know about the need for a large amount of money to fund any infrastructure effort. Yet, the DTC fails to connect these simple dots: the savers of capital and the projects that need them.

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Connecting the savers to money needed for projects
We have heard from the government that they wish to invest Rs 50,00,000 crore in infrastructure by the year end March 31, 2017. The government has also indicated that they wish to see the private sector contribute about 30% of this total spend.
So, the private sector has to cough up Rs 15,00,000 crore over an 8 year period.
This translates into Rs 1,88,000 crore or approximately Rs 2,00,000 crore every year.

Table 1: How our savings stack up.
  In INR, approx In USD, approx
The 30% private funding of the infrastructure spend from domestic sources Rs 2,00,000 crore every year for 8 years USD 44 billion every year for 8 years
India's annual GDP Rs 59,00,000 crore USD 1,300 billion
Household savings / GDP 34% 34%
Household savings Rs 20,00,000 crore USD 400 billion
Infrastructure spend needed / Household savings Approx 10% of annual savings Approx 10% of annual savings
Is this possible? Definitely Definitely

With a GDP of over USD 1,300 billion and an annual savings rate from the households of 34%, there is a pool of USD 400 billion every year in India that can be put to use.

This USD 400 billion of annual savings finds its way into:
1) investments in bank deposits,
2) money spent to buy homes,
3) investments in mutual funds (can someone please tell them about Quantum Mutual Fund!)
4) purchases of life insurance policies, and
5) hoarding of gold, silver, and diamonds.
So, it is not that this USD 400 billion of savings is really lying idle.
Nope, it is pretty much committed.

Taxation can shovel savings where it is needed
The government knows that India needs to build assets and infrastructure for the future. Whether it is ports, power plants, railways, or roads. And the government has admitted that it needs private pools of capital to help.

Wouldn't this have been the perfect time to build a bridge between the long term savings of individuals and the long term financing needed for building infrastructure? Not only the infrastructure as defined by the government but any investment in any business.

With a nudge from a better Direct Tax Code, the savings could be directed a little more intelligently to areas of focus.

Investing in gold is not the ideal thing from an economy's viewpoint and most economists think of gold as an unproductive and dead investment. (Individuals, however, must always own gold because most economists never factor into their excel sheets and forecasts the shocking actions of governments and politicians who can end up destroying economies.)

Also, if infrastructure is built out in a sensible way, it can destroy the value of existing properties in overvalued cities like Bombay and allow those who still need to buy homes (the majority) to buy homes cheaper. Money that is currently wasted on highly expensive homes with no water or power connections will be used to buy less expensive homes with water and power connections. And schools, hospitals, and parks. Since property prices will be dramatically lower, individuals will have more savings.

Table 2: Using taxation to nurture a long term investment approach
Capital gain from investment in listed shares held for: Rate of tax
Less than 1 year Normal business income, the highest slab
More than 1 year and less than 5 years Flat 20%
Over 5 years Zero

The Direct Tax Code should have a clause that reads: "capital gains from investment in shares of any listed company held for over 5 years by any individuals should be free of tax." Such a clause will also allow the government to implement the planned further dilution of its ownership in various listed entities like ONGC, NTPC, and NMDC.

And it will encourage investors to start focusing on long term investments in the share markets rather than the current obsession with speculating. To cement this, the Direct Tax Code should have another clause that reads: "capital gains from shares held for less than 1 year will be taxed at the marginal rate of taxation and treated as normal business income and capital gains from shares held for between 1 year and 5 years will be taxed at a flat rate of 20%".

Using taxation policies is a common way for government's to encourage a certain behaviour or response. For example, the decision to allow interest on home loans to be deducted from income is based on the expectation that individuals would like to own homes and the government would like to be seen to support the concept of "home ownership". The rationale being that a satisfied home owner is more likely to vote for the government that supports such a taxation policy.

Governments also give tax incentives to companies (by way of depreciation benefits) to encourage them to invest more and create jobs. Again, a way to get support at the time of elections.

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How misguided taxation can benefit a few
But not all tax-based incentives are necessarily good.

The tax breaks given to PPF and other such saving programmes look good for us on paper but may not end up being good for us as savers over the long term. We get a higher rate of interest from a tax incentive but - by having the PPF funds at their disposal - politicians can continue to use our money to make good on their vote catching promises to many constituents. These handouts are financed by our savings. Continuous over-spending can lead to a decimation of our savings due to high inflation and a weakened economy. At the end of the day, the people who benefit from these tax breaks are the politicians, not the savers!

At the corporate level, the tax breaks given to SEZ were sold to us as job creation incentives but, actually, were favours to real estate developers and industrialists. The SEZ policy was a slap on the face for villagers whose land was forfeited at low prices. The ridiculously low taxation imposed on forest land that allows large companies "mining rights" is a tax that has taken away land from tribals and effectively shovelled off the wealth to the larger companies. The Maoist movement, according to an article by Arundhati Roy in Outlook, has apparently grown due to such inequalities.

Since taxation policies have ended in "bad" results, could we not use the tax incentives to create a certain behavioural pattern and "good" result? The good result being a better India with more public transportation and more useful goods like schools and hospitals.

But the DTC shows the emptiness of thought process and the vacuum in planning.

Not only have the various ministries shown a lack of an India Vision, but the Ministry of Finance has not shown any ability of linking the needs of the country to build infrastructure with the potential of creating long term wealth for India's own citizens and savers as owners and financiers of these long term assets.

While everyone is busy fighting over the pace of the road construction projects, they failed to build this simple bridge. To connect the dots between the domestic savers and the need to finance infrastructure.

It could be that the powers that be are so caught up seeking advice from the global financial firms because "Invest in India" marketing trips to London and New York to raise the capital India needs is far more fun than the bumpy journey on the dusty roads to Ludhiana and Nagpur.

If you believe that the Direct Tax Code should be amended to encourage long term investment as outlined in Table 2, please click here to suggest the implementation of Table 2.

Your suggestion could be -

I believe that the DTC must give benefits to long term investors by adopting the following tax code for capital gains in listed shares as per Table 1 below. This will also help fund the Rs 2,00,000 crore required from the private sector for funding India's ambitious Rs 50,00,000 crore in infrastructure projects.

Table 1
Capital gain from investment in listed shares held for: Rate of tax
Less than 1 year Normal business income, the highest slab
More than 1 year and less than 5 years Flat 20%
Over 5 years Zero



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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is a Director at Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site. To write to Ajit, please click here.


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11 Responses to "New direct tax code fails to connect the infrastructure dots"

M.G.

Aug 10, 2010

Dear Mr. Ajit, I have been subscribed with Equitymaster since 4 to 5 years and reading your articles regularly, the e-mail address I mentioned here is diff. from regi.'d with Eqty.mast.'r, I agree with your DTC as mentioned in Tabel 1/2,but U may have read the opinion given by some,and I also disagree with your statement that our Government knows that it needs to build infrastructure etc., I believe that our Government knows, but they don't care about common man or poeple of India, every common man of India wants better India, that is better infrastructure, better aminities like Roads, Hospitals, Schools,colleges and food prices to be controlled in a manner that common man or those who are below poverty line can afford, our politicians can afford anything at anycost at anytime, why they should bother, they will only bother about their vote bank and so called seat or chair, and if it is the case than why thoes 70,00,000 crores are lying in the SWISS BANK ? this money is also belongs to the common man of India having paid by the way of so called Tax, eventhough, every common man of this country is willing to pay the Tax for building better India, but they the corporates and businessman getaway with, the reason is they fund their election campain expenses, The virus called Curuption has spreaded in India so dipply from Gram Panchayat to the Top level of Government Offices, the amount of money which is allocated for the development of roads etc. in villeges or towns, out of which hardly 10 % is utilised, many Gram panchayat or Talukas will show on the papper that the roads are pakka, but actualy u will find there is no roads, is there anyone to verify or justify the Taxed money spend for deveopment? do U think these Politician will change their mindset in near future ?, did any of our politicians were punished or penalised or barred from Election ? those, who are charged with curuption/scam or murder ? our constitution does not apply to them, it is only meant for common man of India, or they can change or maintain the constitution to suit them not to the general public. In conclusion, Please don't dissapoint, and not only me but whole India will agree with your opine of DTC, but my Question is who/when will they change their mindset to build better India?
Thanks and keep up the goodones.

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MANASA

Aug 5, 2010

In this country all sectors of people are blaming with each other.All most all are hungry for either power,status,money or a narrow interests.The person who is talking about honesty and the truth ,quite forget about all and do all nasty things after reaching to the top post.Hence it is high time to correct our soul,to change our constitution to make rules which can be followed with out any difficulty.

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Ramesh

Aug 2, 2010

Development of India in true sense can be achieved only by even distribution of facilities and opportunities throughout the country in all villages and towns. The big budget infrastructure spending and GDP numbers are useful only for drawing in FIIs and punters in dalal street and also for grabbing in the educated urban vote by political parties. These numbers and projects do not reflect the actual needs and development of the common man or eradicating the poverty in the country. Such empty talk by educated persons cannot achieve development of the country even with high GDP numbers but can result only in Maoist problems, overcrowding of metros, suicides of farmers and swelling food prices.

Need of the hour are projects in towns and villages which focus on building well equipped government hospitals, schools & colleges with proper facilities and providing essential amenities such as drinking water, power & good roads. These efforts will surely transform India into a developed country in real sense.

BTW, people don’t do any service to the nation by investing in stock market. They invest only for their personal gains, then why should they shy away from taxman.

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R.S. Banatwalla

Aug 1, 2010

I disagree with your contention of taxing capital gain based on the number of years holding alone.
If that be the case than all the promoter, big investors and pe's and mf's would pay no tax on the huge huge capital gains that they make when they sell their shares after 5 years.
This is unjustified. Why should they not pay tax when they are making such huge profits? Can they not afford to share a percentage of their bounty for the common benefit of the of the Society at large?
In my opinion there should be only two types of capital gains, short term and long term. Short term should be within two years and long term should be more than two years. If you sell within one year you pay tax at your marginal rate of tax. If you sell after one year but within two years you pay at 20%
If you sell after two years (long term cg)your first twenty lacs of gains are tax free. Beyond twenty lacs you pay 10% Capital Gains tax on the entire gains.
Is this not fair?

Regards

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Rajesh

Jul 30, 2010

I have been a detractor of some of the things that are mailed in Ajit's honest truth. I sometimes used to say that after all Equitymaster is not that honest sometimes. But this is one the idea, which I will back him completely for the reason that whatever was explained here is completely possible, practical and the need of the hour

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mohan

Jul 30, 2010

I agree with Mr Nilesh that STT is the best and most simplest form of collecting taxes. Instead of complicating the issue, status quo should be maintained with regard to tax on both short and long term capital gains with regard to securities.
These bureaucrats can only complicate simple matters . Idiots

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Abhi

Jul 30, 2010

Hello Ajit,

I tried to post the comments in the MoF link you gave, but it doennt work.
Is it working for others. I tried multiple times.

Thanks
Abhi

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Nilesh Thakkar

Jul 30, 2010

I think securities transactions tax (STT) is a better way to tax the capital market transactions rather than capital gains tax as it is easier to collect and cost of collection will be very low. Moreover, it is almost impossible (barrring dabba trades, ofcourse!!!) to evade.

The merit of long term investing as against short term speculation are also re-inforced in this mechanism as more you trade, more you pay!

Therefore, in my view, governments will do well to avoid taxing capital gains.

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s b singh

Jul 30, 2010

DTC does not take into account the fact that the senior citizens/pensioners, in the absence of any social security system have to bear the brunt of their limited incomes getting eroded due to the inflation and increasing medical and rehabilitative requirements of advanced age.
The problem becomes aggravated if they also happen to be maintaining a dependent differently challenged person for whom again, the DTC is quiet in its present form.
To cater for this significant section of the society in the country and till such time some semblance of social security systems are put inplace, we should have consideration for the following (notwithstanding the thrust of DTC to reduce the categories of concessions):
(a) pension income to be tax free
(b) Some consideration for treatment/maintenance/rehabilitation etc of differently challenged person.
(c) Medical treatment and education expenses be considered for concessions

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Sathya

Jul 30, 2010

I read with interest and difficulty (They are so huge!) some of the numbers given by you. I see you have fallen in to the same trap that our politicians want us to fall into. I disagree with your statement that our Government knows that it needs to build infrastructure etc. They know nothing of that sort, or care. In all your figures, there is no translation in to x no of kms of road, y number of ports, etc. Just some number of rupees with large number of zeros after it.
We all know the real cost of commonwealth games. And the amount of money additionally need if we need to host Asian Games say next year. (Because this infrastructure vanishes in months and we will start all over)
Agreed that tax code should help. The real code should be Companies get 100% tax relief for well planned townships they build. All residents of a road will have zero house tax, if they maintain their road properly. We will at least start small then.
Currently I know this money will be collected from us and spent on bridges to nowhere, some 10 odd kms of road built at some 600 crores per km. (incidentally the figure in Bangalore for 1 km of kacha road currently is 7 crores).
We can claim 9 or 10 or 11% growth as needed quite easily with sleigh of accounting, without any problems. Let us forget big stories and start small. Help citizens with decent garbage disposal system. Encourage all companies to enforce their employees to come in busses companies can buy and run and give incentives to it and fine them for employees who come in cars.
These are things we can do. Rest of the numbers you gave will land up finally in Swiss banks and they will probably get out of recession and also help entire Europe and we get some trickle effect.
Do not penalize small savers. One small incident I want to bring to your attention. We had persuaded most of our help (maid, car cleaner, gardener etc, to invest Rs 100 in NSC every month. This has given them good returns and helped them feel confident. This month onwards, that is gone, They have to produce a photograph (Min Rs 25 for them) and address proof, (many do not have). This is a pro poor policy! Now you advise that this is also taken from them and spent and returned as "Dead Money" you defined!

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